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Managing Director of the Bank for International Settlements

June 2000

The BIS employs the best of the bestfor they are managing and monitoring

their global investmentscountries, development projects, and human, manufactured and natural capital. They cannot allow 1/3 of the world to "go down" (Japan) without shifting resources from one segment to the other.

Entered late - question was being answered by Crockett

Crockett: Forecasting organizationswe do see some risks and obviously asset prices move in substantial ways, it generates developments that are either risky themselves our could create risks if they stop moving in this direction. This is not a forecast that it will happen but it is a warning signal to be prepared in case unexpected developments happen.

Q. In the reportthat stock markets....

A. Volatility over the last year or so has increasedlook at the Asian markets, foreign exchanges markets to see that there have been some substantial moves. The financial systems have coped until now very well. We are of the belief that financial institutions are stronger shape than the volatility but there is some evidence that the market marking capacity the liquidity of markets is not as strong as it was in earlier occasions which means that this volatility could well continue because the capacity to absorb changes in demand, supply in financial markets is not there. If that's the case, then it helps us to be even more mindful of potential vulnerabilities to make sure institutions involved in markets are adequately prepared for this. In our opinion exclude substantial movements. We have got in the world economy imbalances that cannot be indefinitely be sustained-- balance of payments imbalances and associated exchange rate pattern. There is every possibility that those imbalances will be corrected in a smooth manner but we also know that financial markets, on occasions in the past, have adjusted abruptly. In order to prevent that adjustment from turning into a problem for the world economy, the Institutions have to be comparably ready.

Q. More precise on which countries...

A. It is not our practice to name countries or the country who has not...we cannot be too explicit. While everyone takes pleasure and satisfaction that the recovery is taking place in East Asia is taking place much faster than we had expected before, it does have the downside that some of the necessary reforms are now encountering more reluctance to press forward. In our view there is still a lot that needs to be done in order to strengthen the resilience of systems to improve their resistence to vulnerability in the future. That, I believe, the authorities have got a commit to do. It becomes more political and difficult to pursue these reforms when everything seems to be doing well.

Bill White - In a number of these economies, we have seen capital inflows put upward pressure on currencies and in the measure that countries are trying to resist that upward pressure on the currency and do so through intervention there is the risk that they establish a "fixed rate" mentality which is one of the biggest problems that led to the Asian crisis in the first place. People then get induced to go out and borrow elsewhere at a lower rate of interest and expose themselves to a foreign currency exposure which can be costly.

Q. What is your impression now with regard to the value of the euro to the dollar.

A. What we had in last year's report is that we drew a distinction between what you could say about exchange rate relations based on so called parity and what you could say about exchange rate relationships based upon fundamental equilibrium exchange rates looking at the balance of payments. We did not favor either one or did we say one was emerging as the equilibrium. One thing I have learned over the 30 years in this business is that you don't forecast exchange rates and another thing I learned is that the rate for the euro/dollar is an appropriate for those in those countries to comment on.

JV: In light of these economic imbalances we are experiencing, is it the long-term goal of the BIS to come to some type of financial integration not only in the currencies but with the macro/micro economic policies in order to balance out the imbalances?

Crockett: I am note sure if there is a specific anser but where we see the need for greater integration, to use your word, is in the nexus between macro economic policies. What we call micro prudential policies and macro prudential policies, what we mean by that is those concerned with financial stabilitycentral banks and the BISneed to be more mindful in an integrated, open global economy of the way in which the macro economic situation interacts with the situation of individual institutions. How the way regulations affect the individual institutions could have spill effects with macro economics and how what we call "macro prudential" that is to say our overall monitoring of the world economy, needs to take those interactions into account. So we are, I believe, moving forward into an era that those who are concerned with supervision central banks those concerned with monetary policy central banks, those concerned with the interaction between the two need to coordinate their activities much more than they have in the past. We have more manifestations of thisthe creation of the Financial Stability Forum is one. This is first occasion in which the macro economic authoritiesthe central banks and finance ministers meet on a regular basis with the supervisors. This I think is indicative of a new trend.

White: Andrew has focused on the inter-relations between macro and macro prudential. One other aspect is the relationship between the macro and the micro. There I think one of the big imbalances that we currently face, of course, is on the current account side. Particularly with respect to the United States current account deficit. One think that could be suggested is if there were still more vigorous structural reforms in Europe that that would generate increases in profits and increases in investment which would provide substantial stimulus for the European economy. Were that to happen, I guess standard macro would tell you that you would get a stronger euro and by definition a weaker dollar which would provide you with a mechanism current account imbalances would be resolved or be helped.

JV: What about Japan.

White: Japan is a bit of a different case. On the Japanese side, the first thing that we have to hone in on is not the longer run current account problem. The problem is getting that economy moving again. What we suggest in the annual report that clearly fiscal stimulus has been a help but the nature could be made more efficient than it has to date. On that front the almost total reliance on government investment in Japan as opposed to other forms of fiscal stimulus which has to be carefully examined.

Q. ?? Long one by Japanese

A. Crockett: There is a useful distinction between short and long term. In the short-term, U.S. current account deficit has been covered by even larger capital inflows putting upward pressure on the currency and those larger capital inflows have been driven by the perception of profit opportunities in the United States either through physical investment or through investment in financial assets. Over the longer term, however, we know that no country goes on indefinitely with a large current account deficit, although it can happen. We can see in the U.S. strong pressures for inflows. The United States economy is performing very well. But at some stage there is a potential factors that would cause it to change: (1) Increase in profit opportunities in the European economies which would then change the parameters the decisions made by investors, (2) another would be the change of investor expectations with regard to asset prices and (3) the slowing of the U.S. economy to a more moderate pace. All of these could be accomplished in a smooth manner with a smooth adjustment in exchange rates. All that we have said is that you cannot count on financial markets to make the adjustments smoothly. Some times abrupt changes can take place and that is where central banks have to be prepared.

White: to extend this one step to emerging markets. There are a lot of people which look at FDI which has been growing as a piece of good news that in a certain sense that if somebody buys a car factory and this is not hot money, it is harder to get back out. It is important to note that with modern financial markets you can always hedge whatever kind of investment you have and if you do, begin hedging for whatever reasons that will in fact have an impact on exchange rates. So FDI is the good news but don't oversell.

Question: the strong rise in stock prices that does concern BIS?

Crockett: I think there is a potential risk if every time the economy shows signs of slowing the interest rate implications cause stock markets to rise because that means that what you are seeing by evidence in slowing is going to be counteracted by the wealth creating effects in stock prices. It is a natural resultthe swelling in the economythe pace of increase in stock prices will have to come down. If every time the economy slows, the stock market rises, I think we are in a potentially unsustainably situation.

White: If every time the economy slows the stock market goes up because interest rates are expected to come down and every time the economy speeds up the stock markets goes up because dividends are expected to increaseAs Andrew said, this is not a sustainable situation.

Veon: As a follow-up then what would you like to see, what is more sustainable? Apparently we have a herd mentality in the market. What is the better solution.

Crockett: What we would like to see, and this won't be a surprise to you, is a slowing in the economy to what is the long-term sustainable situation with an appropriately valued stock market which is not something you can define or achieve.

Question: Are you suggesting a hard or soft landing?

Crockett: We are not going to get trapped by that question. You cannot discount the possibility of a hard landing. Many previous expansions have ended with a hard landing. In order to minimize the risk with that, the damage, we have to pay attention to the necessary macro policies to slow economy gradually and the necessary micro policies to make sure these institutions are well prepared in the eventuality.

Question: Micro policiesAre banks not prepared?

Crockett: I think banks are quite prepared having experienced the turbulence of the mid 1990s and the aftermath of the LCTM, the Asian crisis, we always OBSERVED MORE PRUDENT BEHAVIOR. The problem is that memories are not long ones in financial markets.

I am not concerned about the excess in the short-term but we should consolidate the lessons we have learned in prudential regulation and risk management practices so that we don't run the risk of forgetfulness in reoccurrence of this policy. END


Veon: when we look at the merger of the macro and micro economics, are most countries comfortable with the fact that there is a change with regard to internal managing of the economy?

White: I think with respect to the managing of the internal managing of the economy, I think people are becoming more aware that this whole process has become much more complex than it used to be and we have an interaction now between supply side factors and demand side factors with respect to the macro economy and an interaction between the macro economy and the financial side of the overall system that is become really much more complicated than it use to be. Since in so far as these complications are concerned, they are fundamentally premised on people's psychology in the way in which they are going to react in the financial marketsit has become more hard to predict. The upshot, I think, while focusing on mean forecasts as people are right to do, there has at the same time got to be greater emphasis put on the uncertainty that faces us and steps which might be taken in order to ensure that should some downside risks materialize in a way the damage can be contained through having made the appropriate micro-reforms, having the appropriate Financial safeguards in place, ensuring that the financial institutions and markets are operating properly. That is the direct which we are increasingly trying to urge people to go.

Veon: With regard to the statement that every time you have an upside in the market people might interpret it reduce the rise in interest rates or downside. Therefore, what do you see as a solution. Do you agree with the OECD report that the U.S. should raise interest rates by 3/4 of 1 % by August?

White: I have no expertise in determining what the Fed should do. The upward trends has been welcomed and if the U.S. economy does not slowthere are emerging signs they are starting to slow but they are not very significant considering how much faster the economy is growing that it should relative to its potential then it seems to me that one cannot rule out the possibility that there would be further interest rate increases.

Veon: What kind of slowing would the BIS like to see in the U.S.?

White: Clearly the rate of grow of domestic demand is significantly above the most optimistic estimates of potential, even in a new era. So what has to happen, and one hopes it will be in an orderly way that demand growth slows in the U.S. both in the interest of regressing that particular gap and also regressing, as it were, the cumulative gap we have had up until now. Until now it has been growing above potential. Clearly the level of demand is above potentialthat level has got to be brought back to the level of potential.

Veon: What is the level of potential and how do you define orderly.

White: The first one is tricky. That is the one Chairman Greenspan and others have been concerned about. How much has productivity gone up because of new era technology, new technology and the rest of it. The answer is that no one really knows. If you take a look at this increase in measured productivity growth against the longer-term track record going back to the end of the war, what we have seen recently really looks like a little blip relative to some of the other movements we have seen in the past so identify a secular change in trend on the basis of what we have seen, is actually is very, very early. What we mean by orderlyyou will know disorderly when you see it.

Veon: When we look at the new economy, am I correct in understanding that not only does Joe Average not understand the impact, but it is not being understood economicallyhow you measure knowledge as a productive tool or indicator versus the brick and mortar.

White: There is a real problem with respect to data. You may be aware that most statistical agencies over the course of the last decade have their budgets cut back, a tendency to say what they could in terms of production of real goods and servicesthe traditional things that they measure. Probably we need more data, better data with respect to the output of services which are inherently hard to measure. They had better put more resources into the problem, having to do with the accuracy of the data, and the relevance of the data. I think most people recognize that in the industrial countries, but it's getting resources to try to address it. It's not just a question of the analytical difficulties of this thing, it is getting the resources to address this issue in a concrete way.

Veon: Then if I understand correctly, everybody on the global level, as a result of the new economy is treading lightly? White: What do you mean? Veon: If it is too new, and there is not a tangible yet, they are trying to measure the best way to react or not react.

White: Absolutely. What you have seen in the U.S. for a long period of time is a willingness to accept the potential reality of a new era and try to avoid "cutting it off in the butt" as it were. What has happened more recently is that it has been a recognition that however optimistic you might be about the new era, that the reaction of the average consumer to what he/she consider to be the reality of a new erathat is to say a perception of increased wealth in asset prices, perception of the ability to spend because of that increased wealth, that regardless of the underlying reality of new era or not, spending was significantly outstripping any potentialany increase in potential --that seemed realistic and that is the reason why the Fed started to move when it did move but or a period of time hesitated because it recognized that there was something important going on in the supply side.

VEON: We have a situation in the United States where consumer debt has exceed mortgage debt, corporate debt is uphow do you see this with regard to world liquidity?

White: Well all of these debt levels have been rising up, particularly on the consumer side. I am not quite sure what the implications would be for liquidity. What I could say is that-- should, in a situation of rising interest rates, particularly if a company by lower asset prices, that people who had been banking on the stock market to support their pension fund and therefore had lowered the American household savings rate almost to zero would recognize that they made a mistake in retrospect and would be forced to retrench and the implications would be reductions in liquidity and a slow-down in economic activity. That could be good news or bad news, depending on how big that slowdown was.